People take out loans for a variety of reasons, from purchasing a car to covering the cost of tuition. When the time comes to start paying these loans back, the number of individual payments, not to mention the total expense, can seem overwhelming. One of the solutions to this problem is debt consolidation, which means taking out one larger loan to pay back all the smaller ones. Then, individuals have only one payment to make each month, and that payment is often less than the sum of the other payments. However, consumers need to take a number of different factors into account before they decide to consolidate their debt. Here are some important points to think about:
Consolidation requires good credit.
One of the downsides of debt consolidation is that you will need good to great credit scores to qualify for the new loan, especially if you want a decent interest rate. However, you can use this fact to your advantage. Many people choose to consolidate once their credit score has improved significantly. This way, the multiple high-interest loans they once took out now have a much lower rate. Before applying, you should check your credit score and report to make sure everything is accurate—and perhaps take some steps to improve the score.
Interest rates are not always lower.
While many people are able to secure lower interest rates through debt consolidation, this is not always the case. You should always keep track of the rates you are paying on each loan and consider whether the refinance is really worth it in the long run. Sometimes, it makes sense not to include a debt or two in the consolidation if you already have low interest rates. The rate offered typically depends on credit, so if rates are not good now, they may improve later as credit scores increase.
Loan terms may lengthen considerably.
Interest rate is not the only factor to keep in mind; another important term to look at is the length of the loan. To get manageable monthly payments, some debt consolidation lenders will lengthen the loan, which could mean that you end up paying more in the long run, even if the loan has a lower interest rate. When thinking about consolidation, understand that longer terms mean more interest regardless of the interest rate. Sometimes, it makes more sense to pay the higher payments if the debt is paid off in half the time.
Fake lenders try to trick consumers.
When you’re applying for debt consolidation, always double-check the legitimacy of each company. This due diligence should be completed before you provide any personal information to the company. Any e-mails from personal addresses rather than the company’s domain should raise flags. You can check with the Better Business Bureau, national trade associations, and other organizations to verify the validity of a company.
Debt consolidation involves fees.
Before signing with any single lender, take a look at the different fees structures that they have. Origination fees can vary a great deal between lenders, as can late fees and other charges. Consumers should avoid companies that impose a prepayment penalty, since these fees are largely considered unethical. If you encounter any unusual fees, you should ask about it. If you do not feel comfortable asking, you may want to consider a different, more trustworthy lender.
Look closely at balance transfer deals.
People often consolidate their debt with balance transfer offers that involve zero or low interest. These sorts of deals are commonly offered to consumers with great credit. However, these great rates are only introductory offers and they come with an expiration date. Even if you intend to pay the debt off during the introductory period, you should always look at the rate, since unexpected expenses can always arise. Also, these introductory offers will often become void if you miss or make a late payment.
Consolidation is not always the answer.
Debt consolidation tends to work best for people who are able to make their monthly payments. Those who are struggling may not qualify and may not even benefit if they do. For people in this situation, other debt relief solutions are available. For instance, the American Fair Credit Council can connect you to reputable debt relief companies, and people certified through the International Association of Professional Debt Arbitrators can help you to negotiate better terms on existing debt.
Bad habits are not cured by consolidation.
Before consolidating debt, some people need to think hard about how they got in the situation they are in and what they can do to avoid it in the future. Those who want consolidation because of a considerable amount of consumer debt should take steps to change their habits—or they could end up in a similar situation again. Following a budget, for example, can help prevent them from overspending again in the future and accruing more debt than they can handle.